A With Profits annuity provides an income that is linked to the investment returns of an insurance company’s With Profits fund. As for all Investment Linked annuities, the income payable can go down as well as up in the future. With Profit annuities do however provide smoothed investment returns. Smoothed investment means, in poor years, your income will not necessarily go down as much as the underlying investments have gone down. It also means that in very good years, not all of the investment return is necessarily paid out (some is retained to cover the bad years). So, With Profit fund returns should be less volatile than other investment funds.
Typically, income is made up of two parts:
A minimum starting income
This is set at a low level but, unless investment conditions are very bad, you’ll usually get at least this much income. Some With Profits annuities guarantee it.
Bonuses
The provider usually announces bonus rates once a year. Bonuses can be both ‘reversionary’ (usually announced once a year guaranteed to pay out for the duration of your annuity) and ‘special’ – these only pay out for a year or so until the next bonus announcement. The amount of bonuses depends on many factors, the most important of which is stock market performance. When you start a With Profits annuity, you normally select an anticipated bonus rate (ABR). The minimum and maximum rates of ABR you can choose vary by provider, but typically, the range is from 0% to 5% and normally once selected cannot be changed.
The provider announces new bonus rates every year. If the rate equals your chosen ABR, your income does not change. If the declared bonus is higher than the ABR, your income increases. But if the bonus is lower than the ABR, your income falls. If you choose a low ABR, your starting income is low. But you increase the likelihood that future bonuses will exceed the ABR and that your income will rise. You also reduce the risk that your income will fall. If you choose a higher ABR, your starting income will be higher. If you choose the lowest ABR of 0% in other words, assuming no bonuses at all, your starting income will be just the minimum. As long as the company declares any bonus at all, your income will increase. In general, your income can’t fall, because the bonus rate can never be lower than 0%. However, if long-term stock market performance were very poor, even this minimum starting income could be cut, except in the case of with-profits annuities that guarantee the minimum.
Some of the products offer more flexibility than others. For example, some providers allow you to change the anticipated bonus rate after the start of your annuity. This gives some control over the income levels and the risk of income falls in the future.
Some providers allow you to convert to a standard annuity (which must be purchased with the same provider) at given points in the future. This means that you can change your annuity to one which provides set income levels and no investment risk. This can be useful if your circumstances change or standard annuity rates change.